PERC 2007: Equity Research Overview and Discussion Karl C. Mergenthaler JPMorgan Chase

A Good Place to Start On Bloomberg, Type ITW Equity DES {GO}

Financial Situation and Prospects Trends  Are metrics getting better or worse?  How do metrics compare with peers?  Can / will metrics get better in the future? Income Statement  Gross, Operating, and Net Margin Balance Sheet  Leverage: Net Debt to Total Capital What is the optimal capital structure?  ROE = (NI / Sales) X (Sales/Assets) X (Assets / Equity) Cash Flow Statement  Free Cash Flow / Net Income Bloomberg: ITW equity FA {go} Historical data in tables and graphs.

Industry and Competitive Analysis Industry Competitiveness: Rivalry among existing firms Suppliers Substitutes Potential Entrants: Barriers to Entry Buyers Hint: Focus on growth and sustainability of sales and earnings.

Industry and Competitive Analysis Secret to success: Do some original research!  Conduct a survey  Interview a customer  Go to a factory  Visit a store  Analyze raw material costs

Valuation Key Inputs  Growth Rate: What is driving growth in sales and earnings?  Interest Rate (WACC) CAPM Multi-factor Arbitrage Pricing Theory Add equity risk premium to LT bond yield Discounted Cash Flow Models  Free Cash Flow Models Firm lacks stable dividend policy Dividend policy not related to earnings FCF is related to profitability Controlling shareholder perspective  Dividend Discount Models Firm has dividend history Dividend policy is related to earnings Minority shareholder perspective

Valuation P/E Growth  Compare to Historical and Peer Group  Meaningless if EPS < 0  Earnings can be volatile  Accounting issues P/B ROE  BV more stable than EPS  Accounting issues P/SOp Mgn  Sales not as volatile as EPS  Sales less influenced by accounting choices  High Sales = High Profits TEV / EBITDA  TEV = Market Cap + Net Debt Bloomberg: ITW equity RV {go} Customize with the drop downs.

Recommendation Investment Recommendation  Buy: Target Price implies at least 15% upside.  Sell: Target Price implies at least 15% downside.  My advice: Take a stand - don’t call it a HOLD. Investment Risks  What could go wrong?  What could change projections?